9 reasons why the stock market could crash in the next 3 months

Overall, this has been another great year for the stock market. Until Wednesday December 1, the reference S&P 500 (^ GSPC -0.84% ) is up 20% since the start of the year. Considering that the widely followed index has averaged a total return of 11% including dividends over the past 40 years, this is a solid performance.

However, the past week has turned upside down for the stock market, with volatility returning in a big way. As investors, we might not like to think about stock market crashes and double-digit percentage corrections, but this is the price of admission to participate in one of the world’s greatest wealth creators. .

Right now, there is no shortage of catalysts that could send the S&P 500 over the edge for its first crash or fix since the start of the pandemic. Here are nine reasons why the stock market could crash over the next three months.

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1. Omicron / propagation variant

Let’s start with the obvious: the coronavirus and its growing number of variants.

This year, the S&P 500 posted more than five dozen record closes. Rising vaccination rates in the United States and around the world were expected to allow businesses to return to normal. But with each new variant of COVID-19, there is the potential for lockdowns, restrictions, additional supply chain issues, and possible decreased spending by consumers or businesses.

For what it’s worth, the emergence of the delta variant in May resulted in a short-term market hiccup that was pretty quickly put in the rearview mirror. The same could be true for the omicron variant, but we just don’t know enough about it for Wall Street and investors to be confident buyers of stocks.

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2. Historically high inflation

A certain level of inflation (i.e. rising prices of goods and services) is expected in a growing economy. However, the 6.2% increase in the consumer price index for all urban consumers in October marked a 31-year high.

The problem with inflation is that it has the potential to undermine the purchasing power of consumers and businesses. Even if wages increase for workers, much of their purchasing power could be reduced by rising rent / housing costs, significantly higher energy prices, and even above-average food inflation. mean.

If the next US Bureau of Labor Statistics inflation reports reach or exceed 6% in the past 12 months, the likelihood that this price spike is transient begins to fade. Wall Street will not like this at all.

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3. Ingestion of energy prices

Crude oil could also spell the end of Wall Street over the next three months.

In my opinion, crude is by far the most volatile commodity. If the price goes too high, consumers and businesses buy less fuel or, if possible for businesses, pass the higher fuel costs on to customers. On the flip side, if crude prices collapse over fears of another variant, it can hurt job creation in the energy sector and even reduce overall confidence in the US economy. or global.

In other words, the oil market must offer some semblance of stability over the next three months. If the price of a barrel goes back above $ 80, inflationary fears could dominate. Meanwhile, if it falls below $ 50, industry-wide investments could be reduced.

A stack of hundred dollar bills fan out on a larger stack of treasury bonds.

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4. Fed talks

The tone and actions of the Federal Reserve could also cause the stock market to collapse in the next three months.

For much of the past decade, the country’s central bank has been extremely accommodating. That is, interest rates have been kept at or near historically low levels, allowing growth stocks to borrow cheaply to hire, acquire and innovate. In addition, the Fed bought long-term Treasury bonds and mortgage-backed securities quite aggressively to encourage lending and confidence in the real estate market.

But with inflation soaring, the Fed will have no choice but to eventually raise interest rates and start slowing down its bond buying program. To put it in moderation, investors have been spoiled by a long period of historically low lending rates. Any discussion of a faster-than-expected rate hike could quickly bring the S&P 500 down.

The facade of the Capitol in Washington, DC

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5. A deadlock on the debt ceiling

Keeping the policy out of your wallet is usually a smart move. But every now and then politics cannot be swept under the rug.

We are currently within two weeks of the December 15 deadline when the federal debt limit is reached. If we hit the debt limit without a deal in Congress, the Treasury Department will not be able to borrow. This means salaried federal employees may not be paid at a time when inflation is rising and the US economy is still finding its money after a nasty (but short) recession. It could even mean that the United States is defaulting on some of its debts, which could hurt its credit rating.

To be clear, this isn’t the first rodeo for lawmakers when it comes to a debt ceiling deadlock. But the longer Congress waits to sort things out, the more likely it is that the debt ceiling will weigh on stocks.

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6. Debt on margin

Generally speaking, margin debt – the amount of money borrowed from a broker at interest to buy or short sell securities – is bad news. While margin can multiply an investor’s gains, it can also quickly magnify losses.

While it is perfectly normal to see the nominal stock of margin debt grow over time, the rate of its increase in 2021 is very alarming. As of October, nearly $ 936 billion in margin debt was outstanding, according to the Financial Industry Regulatory Authority. This has more than doubled since the middle of the previous decade.

More importantly, margin debt increased by more than 70% earlier this year compared to the period a year earlier. According to analytics firm Yardeni Research, there have only been three instances since 1995 where margin debt has grown more than 60% in one year. This happened just before the dot-com bubble burst, months before the financial crisis and in 2021. It doesn’t bode well for the stock market.

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7. The outcome of the memes trade

Twice a year, the Federal Reserve releases its Financial Stability Report, which examines the resilience of the U.S. financial system and outlines some of the most important short- and long-term risks that are worth watching. In the latest report, the country’s central bank looked at the possibility of young investors putting their money to work in stocks even like AMC Entertainment and GameStop could increase volatility and disrupt the market.

The report points out that young investors involved in these transactions “tend to have more indebted households”. Losses in the market would make these people more vulnerable to repaying their debts. Plus, with these individual options buying regularly, the risk is further magnified.

The Fed also notes that social media interactions, including the transmission of biased or unsubstantiated claims on message boards, could lead to increased volatility and a “potentially unsettling outcome.”

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8. Evaluation

Valuation on its own is often not enough to tip the stock market. But when stock valuations hit historically high levels, it’s a whole different story.

On December 1, the Shiller price-to-earnings (P / E) ratio of the S&P 500 was 38, and it had recently reached 40 for only the second time in 151 years. The Shiller P / E takes into account inflation-adjusted earnings over the past 10 years. For comparison, the average Shiller P / E for the 1870 S&P 500 is 16.89.

However, it’s not the distance above its historic P / E Shiller average that is worrying. This is because after the previous four instances where the Shiller P / E exceeded 30, the S&P 500 ultimately lost at least 20% of its value. When valuations become excessive, as they are now, history has shown that crashes become commonplace.

Silver dice that say buy or sell rolling on a digital screen showing stock charts and volume information.

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9. Investors stick to the story

A ninth and final reason the stock market could crash over the next three months is history. Specifically, if investors believe history is repeating itself, the S&P 500 could be in trouble.

Since 1960, there have been nine bear markets. After each of the previous bear market lows, excluding the coronavirus crash, we’ve seen one or two declines of at least 10% in 36 months. In other words, rebounding from a bear market bottom is a process that often runs into speed bumps.

But since the low on March 23, 2020, the S&P 500 has risen almost immediately. If Wall Street and investors bet on the repeat of history, they could lighten their portfolios pending a double-digit drop or crash percentage.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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